The stock market took a breather on Monday following its recent successes. Observers blamed the slower day on “fretting over Greece” again. But the euro overcame early weakness and closed higher against the U.S. dollar, which doesn’t fully support that thesis. From the viewpoint of technical analysis there are other reasons for the market to rest.
At the close, the Dow Jones Industrial Average was off 17 points at 12,845, the S&P 500 fell a point to 1,344, and the Nasdaq lost 4 points to close at 2,902. The NYSE traded 686 million shares and the Nasdaq crossed 420 million. Decliners led advancers by 1.4-1 on both exchanges.
On Monday, I mentioned that the S&P 500’s break from a small inverse head-and-shoulders formation that appeared in November and December provides a short-term target of 1,378. But what about a long term target?
One publication quoted Bloomberg on Jan. 3: “Valuations for U.S. equities have been stuck below the five-decade average for the longest period since Richard Nixon’s presidency.”
That average evaluation is 16.4 times. Multiply that by the expected earnings of the S&P 500, which is $104.78, and the target is 1,718, which would be very nice, but with current world tensions it may be a bit optimistic.
At the present level of 1,344, with an assumption of $100 to $110 earnings (Jeff Saut’s estimate), the S&P 500 is trading at a very modest P/E of just 12.2x to 13.5x. My guess is that the index should trade at about 15 times earnings. There are so many factors that could influence the ratio (Greece, Iran, China, Syria, etc.) that we must admit that we live in abnormal times. But 15 times $105 = 1,575.
Supposition: A breakout by the S&P 500 above 1,345 could be from a huge inverse head-and-shoulders formation. The formation has a double head at an average of 1,120. To calculate the target, take the distance between the head and the neckline and add it to the neckline. Thus, 1,345 – 1,120 = 225 + 1,345 = 1,570, just 5 points from 15 times earnings.
That target is a mere 16% from yesterday’s close, which is exactly how far the index has traveled since its August to October lows. Surely stocks are due for a rest following such a run and there appears to be signs of exhaustion.
The dollar via the PowerShares DB US Dollar Index Bullish Fund (NYSE:UUP) seems to be oversold, and if Greece breaks from the EU, the dollar should strengthen. A strong dollar usually leads to lower stock prices, and so tomorrow we will examine what to expect in the way of a pullback or consolidation.